The Opportunity Cost of Mining Fads & Boomlets

Harking back to my days studying economics, one of the concepts that has most stuck with me and indeed has almost become a guiding principle is that of “opportunity cost”. In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone, where a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the “cost” incurred by not enjoying the benefit that would be had by taking the second best choice available.

The New Oxford American Dictionary defines it as “the loss of potential gain from other alternatives when one alternative is chosen.” Opportunity cost is a key concept in economics, and has been described as expressing “the basic relationship between scarcity and choice.” The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.

When we apply it to mining we are thinking that one dollar given to a no-hope story is one dollar less for a “serious” story. While that misallocated dollar may seem immaterial in the easy money days like 2007 or 2010, in the lean times it can be the difference between a worthy project, run by determined people, surviving or not. There has been a massive misallocation of funds in the mining space and some of the most egregious examples have been in the specialty metals that have been subject to boomlets and fads over the last decade. In the final wash the unworthy have ended up ultimately disappearing no matter how much money was thrown at them and the collateral damage has been the starvation to death (or near-death) of those with projects that might have made a realistic contribution to global supply in their respective metals.

Here we shall review the scope of this opportunity cost and the price that was “paid” by choosing the path less travelled of seriousness and gravitas.

Rare Earths

Has there ever been such a great destruction of value, by so few, in the mining space, in so short a time, as the Rare Earth boom of 2009-12? By our estimate around $8-10bn of value was “destroyed” in the process with, so far, the only thing to show for it being the production flows from Lynas.

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Past estimates have claimed that the REE surge involved over 300 companies. This still challenges our imagination and we suspect it includes any party that even muttered “rare earths” under their breath at a cocktail party. By our count there was one in London, one in Germany, one in South Africa, between 10-15 in Australia, two in the US and somewhere between 60-100 in Canada.

How does one measure the destruction of value? Is it the amount of capital raised that now no longer exists in balance sheets with an asset of the same value? We would frankly prefer the change from peak market cap (no matter how realistic that might have been in most cases).

Molycorp was of course the biggest black hole but like any universe there is always more than one black hole. Using change from peak market cap (and excluding Molycorp) one can see that billions have been wiped out by just tallying up Avalon, Rare Element Resources and Lynas. Hundreds of millions more in market cap were wiped out by the retreat from peak values at Great Western, Frontier and Arafura. To these must be added the total peak market caps of the “rest”. Some never got more than $2-3mn market caps, but quite a lot could manage several tens of millions in valuation, albeit briefly. Thus we would be looking at $1-1.5bn lost in the “rest”. Some have salvaged value like Ucore by going into technology/patents and Quantum Rare Earths preserved its market cap by becoming Niocorp and shifting metal. Medallion morphed from a wannabe miner, to a wannabe processor and now is neither.

As part of another exercise, we totted up the number of companies we now think will (maybe) make it to production, or are in production, and it came to a mere seven. Rare Earths have become the mining space’s equivalent of the dot-com bust. However, one can draw hope that Facebook, Twitter, Linkedin and Google were not even around (in public markets) during that bust and maybe the Rare Earth giant of 2025 is a company not yet even formed. Though Lynas looks well-positioned to take that title.

Lithium

This was the first boomlet off the taxi-rank after the shock and awe of the global financial slump of 2008. However, it was built upon an already established though admittedly small group of very large producers (i.e. the cartel). That universe burgeoned to around 20-30 wannabes pretty fast but some never found roots and went away rather quickly. In any case the Vancouver promo-listing machine had scarcely started to crank its gears before the REE boom came along and stole Lithium’s thunder. There was also a perception that two or three of the projects coming on stream would satisfy mid-decade demand so this calmed some of the more fevered claims that could be made.

By late 2010 the focus was elsewhere and the sector was left to get on with business. Galaxy was added to the ranks of producers, while others like Orocobre and Neometals (back then Reed) worked away on their projects which are now coming to fruition. Quebec Lithium managed to go all the way to production then stumbled. Talison made it to production and was snapped up. Nemaska proved to be the most durable Canadian player. In Australia, General Mining has been added to the producer mix via their earn-in to Galaxy’s Mt Cattlin.

This group of lithium companies now have a powerful lead. The latest price uplift in the metal has drawn a number of new players into the fray. Most will be years away from production, even with the best will in the world. It will be interesting to see if the market disciplines itself and keeps the number of entrants down.

The opportunity cost of this space has been much less than in others. The takeover of Talison for over $700mn made investors way more money (net/net) than was lost from the few juniors that expired or the other players that lost market value.

Graphite

While we encountered Northern Graphite as far back as 2009, the investor enthusiasm for graphite did manifest itself broadly until 2013-14 and peaked rather swiftly. The dizzying array of flake types boggled an audience that had only just got their brains around the many Lanthanide elements. The fact that some of the graphite stories were rehashed REE vehicles also gave investors a sense of caution. Our antennas started waving when we met a company called Canada Rare Earths that had the powerpoint in its new name as Canada Graphite but still was registered as the old name. It now is called something totally different and is reporting gold sampling results.

The universe of graphite players was never much more than 25 in number. Most are still around, some still have sizeable market caps. Most are probably going nowhere and will be repurposed as gold or something else. Value destruction here has been limited to maybe a few hundred millions. The potential for more to be lost exists though if some of the big players do not deliver and instead wither on the vine. The “serious” players may very well be below the radar still.

Uranium

This space might be nuanced as a recurring fad with an overlay of seriousness and production. In this category it is now being joined by Lithium. Like the others it revives or retreats on price trends but it is not driven by technological advances because in its big picture not much has changed since the 1960s.

Pay Day?

The ultimate payday for any mining story is a takeover. Also good is an ongoing flow of dividends, but that is a rare thing indeed, particularly in Canada, where executives dangle the prospect of a takeover as an excuse to not pay a dividend. However when it comes to the types of stocks we are talking about in this research note, dividends are unlikely as so few of the contenders have even got within spitting distance of having earnings from which to pay a dividend.

So what of takeovers? In the graphite space we can think of none. In the Rare Earth, the shocking thing is that could have been so many players and yet so little action. The only transactions we can recall involving publicly listed targets was the merger between Molycorp and Neomaterials and the takeover by Great Western of the JSE-listed RareCo. The latter was a transaction not many noticed and even we are not too sure if RareCo was delisted or in administration at the time that it succumbed to GWG’s charms.

Lithium stands out as a space that had transactions right from the get-go. Literally the ink was not dry on our research piece on Admiralty Resources’ Rincon deposit when that asset was taken over by the Sentient funds. A little while later, Salares Lithium absorbed the unlisted Talison Lithium (controlled by Resource Capital) and created a vehicle that was then a target for a Chinese buyer with an outsized $738mn offer, from which it later resold part to cartel-member Rockwood, which was itself recently taken over by the chemical company Albemarle. Other transactions have included Galazy exiting its Chinese processing plant by selling out to its Chinese partner and now Neometals cashing out (partially) from its Mt Marion deposit to Ganfeng. Another merger in the space was the recent combination of Western Lithium with Lithium Americas. If the measure of a real “boom” over a fad is corporate actions (and no, a press release of surface samples is NOT a corporate action) then Lithium definitely qualifies over the other two mining sub-spaces.

Conclusion

What constitutes a “serious” story? If we wind back to 2010, the “serious” stories in Rare Earths were those with the biggest market caps, enormous ambitions and large resources (invariably in very challenged locations) and advisory boards freighted with a slew of academics and boffins that had not seen daylight since the 1950s. Almost all of these have not stood the test of time and their demise is now mentioned with guffaws and titters of laughter rather than reverential sighs with their fatal flaws (literally and in the scientific sense) being all too obvious in retrospect. One in particular that had the word “lake” in its project name (mainly because it was under one!) thought it would escape geographical destiny by going aboriginal in a name change. Not unsurprisingly that did not work.

The ancient Egyptians believed they could weigh goodness in the afterlife, and often pictured a god with some scales with a feather in one side and a soul of the dead in the other. The mining sector felt that “seriousness” could be weighed with a project in one side of the balance and a stack of Resource Estimates, PEAs, PFSs and BFS’s on the other side. As destiny has shown these products of the consultants might have been the Book(s) of the Dead.

Looking back to the graphite space, the company that struck me as the most serious from the get-go was Elcora with its dinky little mine revival story in Sri Lanka. Less than 18mths later it’s in production and they are working towards a processing plant in Europe. Its price is on the up while everyone else’s is sagging. It ticked none of Toronto investment bankers’ boxes of “seriousness” and yet is now maybe the most serious of the whole lot.

Then there is Lithium. In the beginning there were Lithium producers that really doubled as chemical companies (or vice versa). They were big, they were dominant and they had been around for decades. Then appeared the baby-boomers of the space and these transitioned into producers, Talison, Orocobre, Galaxy, Neometals and Nemaska. Several others will follow. The first batch were winnowed out by the long drought of investor interest now there is a second phase, largely price driven that has brought in new names. Some of these are real (dare we say serious) while others are carpetbaggers. Time will tell.

In the Darwinian world of mining it seems that the loudest inherit the earth (for a short while at least) until the more persistent and nimble start to pull ahead of the pack. The greatest problem is that the loudest (like any squeaky wheel) get the grease and indeed hog the grease to the detriment of everyone else. The opportunity cost of the failure of bankers, analysts, consultants and investors to discriminate between the real and the surreal is that enormous amounts of money are squandered on transient companies, projects and managements while the worthier projects, maybe run by managements without a bullhorn are the victims of the misallocation of funds. It is the task for all those in the industry to redefine “serious” and spy out and weed out those that fail that test before they have consumed what we now know to our grief are ultimately finite funding resources.

Comments

Tracy Weslosky

Owning the only FTSE recognized rare earth index in the world, I tracked rare earth companies and at the height, I was following closed to 350. Recently, I found a photo of Dan Cordier on BNN a few years ago when he was with the USGS, and the sub-header stated “over 600”. During PDAC a couple of weeks ago, I mentioned this in a presentation that I attended on the sector at the Albany Club, and I was corrected by someone — that there were actually as many as 700 at that time. This said, we continue to maintain support for the approximately 2 dozen companies that continue to drive towards production. Note that ALKANE, PEAK, UCORE and SEARCH MINERALS will be at our CLEANTECH & TECHNOLOGY METALS SUMMIT May 10-11th and I am hoping that several others will confirm shortly. We DO have leaders in LITHIUM and GRAPHITE also attending. More on Monday….

An excellent review of how promotional dynamics utilizes unanalyzed awareness of problems to shift money from the suckers to the suckees while end users just stay on the sidelines awaiting the results of economic Darwinism.

I have spent a great deal of time and effort researching, participating in, and analyzing the rare earths and graphite markets to select long term survivors and successes. In Rare Earths I choose Ucore for the same reasons you do; it has morphed into a technology company. I will go further than you did to predict that Ucore or a successor in interest will become a great consolidator in non-Chinese rare earths, or, at least, become the go-to company for rare earths processing and more.

In graphite I think that Canadian based Elcora is not only already a producer but a clear leader in high technology applications of graphite such as lithium ion battery anodes for today’s markets and mass produced graphene for the day after tomorrow’s markets. I note that it is building a graphene “foundry” in Halifax, NS, and is looking for locations for battery graphite production in Europe and North America.

I have not yet found a non-cartel lithium supplier that I think will become a winner, but again it will be one of the juniors that is merging mining nad processing technology or perhaps one that just has processing technology.

Recycling

Each of the supply chains; those of rare earths, lithium, and graphite have the same deficiency: They lack circularity. This means that they are not recycled for maximum effect. I mean that recycling should be first and foremost economical but it must always capitalize the social value of reduced pollution and of industrial independence by nations that need self-sufficiency in order to grow.

Ucore and Elcora are addressing those issues for rare earths, technological graphite, and soon, if the lithium space does not do it then also for lithium.

A Washington pundit said to me last week “No more support for just holes in the ground. Now we need to make the best out of what we already have.”

Well Jack, a lot of respect for you, but Ucore is another sucker or suckee. they are just a bit more smarter than others. “Technology company” is just another layer of complexity or look good effect for those well informed fund managers. Especially if the technology you are promoting is complex.

My goal here is not to single out companies because they did what they did and failed at it. And not all did fail because there are small band of survivors (somewhat like the Poseidon Adventure of mining)..

However my point is that if we take one example, Avalon, we can see that the money “invested” in that company at its peak (nearly $1bn) could have put towards making real three of the type of projects that, for example Peak Resources has, for the amount of value reduction that Avalon’s market cap has suffered.

My problem here is with the term “invested.” The only money actually received by the company is from the direct sale of its equity as IPO “shares” or from later equity sales in other “placements.” The overwhelming bulk of the money used to buy shares went to buy shares not any longer owned by the company. Higher share prices in the market at best allowed the company to make some money by issuing private placements at higher prices. I will bet that 75% or more of the market caps was made or lost by traders.
This is true even of Molycorp, which alone among (then) juniors sold enough shares in its IPO and in subsequent placements to build and operate a mine. That it did not do so profitably was mostly due to the failure of its business operations model and a general technical and administrative incompetence. We never got to even know if the remainder of the juniors were competent at running a mining operation profitably because none of them other than Lynas ever even brought a deposit into.operation as a mine.
I wonder when companies that depend on critical raw materials will get smart enough to see that it is the short-sightedness of the market that is the problem and that they themselves have to make long term investments in security of SUPPLY.

I agree, Jack. The vast majority of “investors” are day-traders and short-term profiteers looking to exchange gains and losses with other similarly-minded individuals. In this sense, it is only one notch above gambling. Less common are long-term investors who hold their investments for at least years, preferably decades, supporting a floor on the stock price, supporting a belief in a long-term improvement to our country, and perhaps also supporting their own long-term financial well-being. Better yet, as you indicated, are cases of direct funding to the company when those purchases aren’t on the open market, but are during initial and subsequent public share offerings. Difficult job for an investor to distinguish between which companies are making genuine and sustained efforts to bring a concept to fruition, and will patiently stick with it through difficult markets for years, versus those companies whose intent is to string along the public and collect investment revenue along the way. I’ll suggest that a key indicator, though not necessarily sufficient, are those companies where there is a strong percentage of insider ownership of stock, which increases the incentive to minimize share dilution, and make efficient use of the funds that are available.

The referenced “strategic” or “technology” metals and minerals don’t hold a candle to the likes of coal, iron ore, nickel, and almost certainly the all-time king, gold, for recent or historical loss of value. Regardless of the august crown-holder, hail to the “dumb” money, for without it there would be no “smart’ money. In fact, the former and latter are often one and the same investor. Mining is especially challenging because of the convergence of a long time line (sometimes 15 years and multiple owners from first drill to initial production), macro elements (like incredibly volatile commodity prices), and micro elements (such as management, extreme capital intensity, and a “good or bad” deposit facing immediate depletion without obvious replacement once targeted mining finally begins). Hindsight, in mining as in life, makes us all smarter about why something happened but still no more prone to getting it right the next time as much as anything because mining is a series of truly heterogeneous rather than homogeneous (widget-like) stories. It is in fact this risk, and the allure of a lottery-ticket win, that I suspect keeps people coming back across (emotionally-charged) cycles; thank goodness.